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Bank hints at future rate hike

The Bank of Canada held its key interest rate at 4.25 per cent Tuesday, seemingly quashing any expectation that rates will fall this year.

Governor David Dodge leaves the Bank of Canada building in Ottawa, in this October 2005 file photo. (CP PHOTO)

By Julian BeltrameCanadian press

Tues., April 24, 2007

OTTAWA – The Bank of Canada held its key interest rate at 4.25 per cent Tuesday, seemingly quashing any expectation that rates will fall this year.

The decision to hold the line on the overnight target rate had been widely anticipated by economists, but the bank hinted at a possible future rate increase by indicating it views inflation as a greater risk than slow growth.

"The upside risk to the bank's inflation projection is that the recent strength of inflation could be more persistent than projected," the bank said.

"The bank continues to judge that the risks to its inflation projection are roughly balanced, although there is now a slight tilt to the upside."

The bank last changed the policy rate last May, when it bumped it up a quarter of a percentage point.

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Sifting through the bank's tea leaves, economists said the signal was less than hawkish but more than simply neutral, meaning that bank governor David Dodge's bias leans toward raising rates despite slower than projected economic growth.

"We continue to believe that the bank's next move will be a modest rate hike in early 2008, and there's nothing here to deflect that view," said Douglas Porter, an economist with BMO Capital Markets.

In its announcement, the bank predicted the economy will grow 2.2 per cent this year and 2.7 per cent next year and in 2009, a slower pace than the 2.3 per cent and 2.8 per cent projections it had made in January.

And it acknowledged that the American economy continues to underperform, putting even more pressure on export-oriented Canadian businesses.

New statistics out of the U.S. on Tuesday showed sales of existing homes continued to plummet in March, falling by 8.4 per cent from February. And April's consumer confidence index deflated to an eight-month low.

"What is clear is that the housing market correction in the U.S. is not over," said Meny Grauman of Scotia Capital. "There is more pain to come."

But the Canadian central bank downplayed the lower growth projections, saying growth "has been essentially in line with expectations" and the economy operated above its sustainable capacity in the first quarter.

Pressure on capacity over the past year has been stronger than projected, and the increase in food and gasoline prices has been above projections, the bank said.

It said the Canadian economy would be growing faster but for reduced demand for Canadian goods in the U.S.

Robust domestic demand continues to be the main driver of the economy, it said, while strong growth outside North America is pushing up demand and prices for commodities.

The bank's focus on core consumer price inflation, running at 2.3 per cent in March, should worry manufacturers, said Bob Tebbutt, vice-president of risk management for Peregrine Financial Group Canada.

This emphasis suggests the bank is unconcerned about the strength of the Canadian dollar, now about 89 cents US, a level at which Tebbutt said Canadian manufacturers will continue to struggle to export to America.

"The way the bank is talking, I don't think they will reduce rates, but I think they should," he said.

If the U.S. economy continues to limp along, the Federal Reserve Board may be forced to cut interest rates in the third quarter, said Camilla Sutton, a currency strategist with Scotia Capital.

"Our economy is very integrated with the U.S. and if the Fed cuts rates, I think we'll have to follow," she said.

The Canadian central bank will issue an updated analysis in its monetary policy report on Thursday.

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